capital structure

Topics: Corporate finance, Capital structure, Finance Pages: 44 (6493 words) Published: April 30, 2014
African Journal of Business Management Vol. 5(15), pp. 6527-6540, 4 August, 2011 Available online at
DOI: 10.5897/AJBM11.1012
ISSN 1993-8233 ©2011 Academic Journals

Full Length Research Paper

Capital structure and financing decision - Evidence
from the four Asian Tigers and Japan
Kuang-Hua Hsu1* and Ching-Yu Hsu2

Department of Finance, Chaoyang University of Technology, Taiwan, Republic of China 168 Jifong E. Road., Wufong District, Taichung City 41349, Taiwan, Republic of China.
Department of Finance, National Taiwan University, Taiwan, R. O. C, No.1 Sec. 4, Roosevelt Road, Taipei, 10617, Taiwan, Republic of China.
Accepted 14 June, 2011

This paper examines the relative importance of the Modigliani-Miller theorem, the trade-off theory, the pecking order theory and the market timing theory in the financing decisions of the firms for the Four Asian Tigers (Hong Kong, Korea, Singapore and Taiwan) and Japan. According to our findings, although several elements impact on capital structure temporarily, firms from all countries rebalance their leverage following equity issuances. The results are more in line with the dynamic trade-off theory rather than the equity market timing or pecking order hypothesis of capital structure. In other words, firms have their target capital structures, determined by the marginal benefits of debt and costs associated with debt. Therefore, this implies that firms adjust their capital structure in response to the temporary shocks that cause their leverage to deviate from the target in the Four Asian Tigers and Japan. This outcome would be consistent with the previous empirical evidences of the US and the other of the Group of Seven (G7).

Key words: Capital structure, trade-off theory, market timing hypothesis, pecking order theory. INTRODUCTION
The capital structure refers to the way that a firm finances its assets through some combination of financing
sources. The first choice is internal financing which is the using of profit or retained earnings as a source of capital
for new investment. The second choice is external
financing which is the usage of new money, such as
equity, debt, hybrid securities, from outside of the firm
brought in for investment. Based on different kinds of
financial decisions, the capital structures of firms could be shaped differently. Eventually, it is an important issue for managers how to minimize financial costs and maximize

*Corresponding author. E-mail: Tel: 886423323000. Abbreviations: EFWAMB, External finance weighted-average
market-to-book ratio; M/B, book ratio; PPE, property, plant, and equipment; FD, financial deficit; EBITD, earnings before
interest, taxes and depreciation; YT, yearly timing; LT, long-term timing; OLS, ordinary least squares.

shareholders’ equity. The Modigliani-Miller theorem
(Modigliani and Miller, 1958), the first relevant theory of
capital structure, states that the value of a firm is
irrelevant to how that firm is financed in a perfect market. However, the real world reflects the firm’s value is
relevant with its bankruptcy costs, agency costs, taxes,
information asymmetry and so on. That is why a firm’s
value is affected by the capital structure it employs.
Therefore, since Modigliani and Miller’s irrelevance proposition, researchers have investigated firms’ decisions about how to finance their operations. Based on the
practical contradiction of the Modigliani-Miller theorem,
two traditional theories of capital structure, the trade-off theory and the pecking order theory, are developed. The
trade-off theory considers that firms have a target capital
structure that is determined by the marginal benefits of
debt, for example, tax advantage of debt and costs associated with debt, such as bankruptcy costs and agency costs (Jensen and Meckling, 1976; Myers, 1977). In other
words, trade-off theory implies that firms adjust their
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